If you've got the cash flow and you've paid your mortgage down, investing in property can be a wise move.
Conventional wisdom would hold that paying your home loan off quickly and getting yourself out of debt is the wisest financial move you can make. And certainly, for the majority of your home loan term, devoting extra funds to paying down your mortgage is a wise move. But as your home loan nears the end of its term, that extra cash could be used more productively.
Financial expert Noel Whittaker says the effects of compound interest demonstrate why it's a good idea to look for an additional investment as your original loan term comes to an end.
"How compound interest works is that as the loan term increases, small increases in payments make a big difference," he says.
For instance, if you owe $550,000 at 4.5% interest being repaid over 30 years, your monthly repayments will be $2,786.77 and you will pay a total of $453,236.91 interest. If you pay an extra $270 a month, you can take 5 years off the time it takes you to pay your mortgage and you will pay $367,202.21 in interest, saving yourself $86,034.70. To reduce the loan term from 30 to 20 years, you would need to pay an extra $690, taking total repayments to $3,476.77 and paying $285,514.95 in interest. But once the loan term is down to about 10 years, extra payments don’t help borrowers as much as if extra payments were being made on a 30 year loan.
"Once you reach a certain point in the loan term, about 10 years, compounding interest doesn't matter as much any more. Once you reach a 10 year term, you’re better off using your money to invest. If the mortgage is under control, you’ll save little to no interest on upping the payments and you’re missing out on what could have been five to 10 years' growth if you invested in another property," Whittaker says.
Good debt and bad debt
The decision to take on more debt by investing in property might require a bit of a shift in thinking. While Australians currently carry a record level of household debt, younger Australians are keen to get out from under this debt as quickly as possible. A 2018 ING study found that 55% of millennials considering a personal loan placed high value on the ability to repay the loan early.
But, strange as it might sound, not all debt is bad debt. High-interest debt that curtails your cash flow through the form of monthly repayments could certainly be considered bad debt. However, debt taken on to invest in an income-producing and wealth-creating asset, such as an investment property, is debt that's productive.
Buying an investment property rather than paying off your home loan allows you to produce rental income, enjoy tax benefits from negative gearing and eventually see a capital gain from the sale of the property. In this light, taking on a bit of extra debt doesn't seem unreasonable.
Think carefully
Financial Spectrum managing director Brenton Tong had this to add on making up your mind about taking on a second home or investment loan:
"The decision to invest in another property when you already have a home loan is a pretty big decision because you’re taking on more debt. Probably the most important consideration is your financial position at the time when you’re going to be looking at doing that, and the number one factor when you’re looking at your financial position is your cash flow," Tong says.
"You can have an enormous amount of equity in your property and you could almost have your property paid off, but if you don’t have the available cash flow to fund additional debt then you’re going to be putting yourself in harm's way. If, on the other hand, your debt is quite high and your equity is quite small yet you still have an abundance of cash flow, then quite possibly you might be in a position where you can get into property investment much earlier than you think you can."
Comparing home loans is a great way to grow your knowledge about your options.
I am 61 and my husband 58. I no longer work but my husband still does. we have one property valued at around 380,000
we have 300,000 in bank and have kept a home loan of 100,000
this is offset by money in the bank and the rest of the money is earning interest at 3.6%.
My question is do i pay of the mortgage, we will still have 200,000 in case we need it.
my husband earns 95000 gross per year. and has superannuation. my superannuation is part of that 200,000. what is the equation for it to work for an investment property?. we would be hoping to resell the property in 5 years. how much rent would you need to be getting if you paid 260,000 for a property.
Hi Colleen,
Thanks for your question.
Please note that finder.com.au is an online comparison service and is not in a position to be giving financial or investment advice.
Regretfully this question is beyond the scope of this forum. It is recommended that specialist advice be sought from a financial planner.
Cheers,
Shirley
My husband and I have recently bought our second investment through a brokerage agency.At the time my husband’s income was treble to what it is now.We also own another investment property which is more than 40 years old, we pay tax on the rental income from this property as is more than the expenses.We are also paying off a mortgage.Would we be better off selling the old property and pay off our mortgage and keep the new investment or not
Hi Raelene,
thanks for the question.
I would recommend contacting a trusted financial planner to get an answer to this question which will take into account all of your personal circumstances, including tax and more.
Sorry I couldn’t be of more help,
Marc.
Hello, we currently own our home in FL, with only $25K owing on an equity line of credit. We also owe $12,500 on a bank credit card. Our home is valued at approximately $275K. We live in Australia & pay $1100/month rent. Would it make sense to purchase a home or unit in Australia instead of paying rent each month? We rent our home out in FL about 6 months/year which covers most of our monthly expenses. Thank you
Hi JD,
Thanks for your question.
Unfortunately we don’t provide financial advice on finder.com.au. Please speak to your trusted financial planner to help you with this.
Cheers,
Shirley
Currently have two properties, however have lost my job, have rental coming from one property of 1700 and another coming in at 1500 a month, currently paying off both home and investment property, ANZ won’t structure or refinance differently for me, also have a line of credit am up to 50 now, limit is 80, am running out of ideas to save both homes, is there anything I can do apart from selling one, now before it gets worse, or is there a way to keep both going, am on temporary work as of Monday, but need some help fast,,!
Hi Teena,
Thanks for your comment.
Please see this page about your options, otherwise it may be worthwhile to seek financial counselling.
Hope this helps,
Shirley